Q. Define the Prices and price level?
Prices are of great significance in macroeconomics as undeniably they are in microeconomics. Though in microeconomics we are more interested in prices of individual services and goods and such prices are hardly important for the economy as a whole however there are exceptions (for instance, price of oil). In macroeconomics we are more interested in how prices change on average. We define the pricelevel like a weighted average of many different prices.
If p1 is price of gasoline and p2 the price of oil then 10p1 + p2 is a price level. It's a weighted average of two prices with weights 10 and 1. Generally price level is defined using many more prices.
The reason for employing different weights is that some prices are more significant than others for the economy. Price of gasoline, for instance, is much more significant than price of paper clips. By using different weights we enable changes in some prices to have a larger effect on the price level than changes in other prices.
Exactly the prices which are included in the price level and weights which they carry may vary. Different choices give rise to different measures of price level. To visualize the prices and weights which are included, we use concept 'basket' of services andgoods.
We may, for instance, create a basket that contains all the goods sold by a particular store on a particular day. Price of this basket is then a price level - it would be a weighted average of the prices of goods sold that day and weights would be equal to the number of every good sold. Perhaps the basket comprises 100 litres of regular milk though only one frozen cake. Price of regular milk will then have a weight of 100 whereas the price of frozen cake will have a weight of 1. Changes in the price of milk will then have a larger influence on the price level than changes in price of frozen cake.
Note: in macroeconomics, it's common to use the term 'prices' or 'price' as short for price level. The expression 'prices rise'must be interpreted as 'the price level rises' - it doesn't mean that all prices rise.